The high cost of waiting to buy permanent life insurance

By Ken Godfrey

Life Insurance Financial Evaluations, LLC

This analysis highlights the importance of evaluating and understanding life insurance alternatives and policy management expectations. It is often more financially prudent to secure some level of permanent life insurance upfront to save on long-term costs. In addition, a permanent life insurance purchase avoids the significant cost increase of converting term insurance to permanent coverage at later ages and the risk that the conversion privilege will expire before utilization.

Many people struggle with the decision to buy life insurance and often delay the purchase. Delaying the purchase of life insurance, whether for term or permanent coverage, can be a costly decision. For those who ultimately need permanent life insurance, buying it now is a much less expensive option in the long term compared to waiting to purchase it later in life or buying term insurance with the intent to convert to permanent insurance at a later date.

Insurance coverage becomes more expensive with age. People often choose to buy term insurance since it is the least expensive and easiest to understand form of life insurance. Many term insurance policies offer conversion privileges that allow a policyholder to guarantee their insurability and convert to permanent insurance at a later date without new underwriting requirements.

There are inherent risks, however, to buying term insurance with the intent of converting to permanent insurance. These risks include the policyholder forgetting when the conversion privilege expires, the carrier not offering competitive permanent products to convert to, or the permanent policy priced at the then older age resulting in much higher premiums than anticipated.

As a result, consideration should be given to buying a base level of permanent insurance today, if it is within the purchaser’s budget. Additional term insurance policies can be used to meet the total insurance needs and stay within the pre-determined insurance premium budget.

When buying permanent life insurance, the policyholder should commit to paying premiums even during difficult financial times and plan to hold the policy to mortality. The purchase of permanent life insurance needs to be viewed as a long-term financial obligation. Therefore, it is financially prudent not to buy more than one can afford and stay committed to. Over the long term, buying permanent insurance now will reduce risks and save money over the insured’s lifetime if the insured lives to average life expectancy or beyond.

Let’s look at an example

Consider a 35-year-old male in good health exploring the new purchase of $1 million level insurance coverage. For this analysis, we will assume life insurance product pricing from an A.M. Best A+ rated carrier with competitive term and guaranteed universal life products. Other insurance products such as whole life, variable life or equity indexed life are available for purchase depending on the clients needs and risk profile, but for this comparison we will assume a GUL purchase is most appropriate for the client’s needs. If the insured qualifies for preferred non-tobacco underwriting, the insured can purchase a GUL policy with an annual premium of $4,426 and a guaranteed death benefit to age 121.
Based on the 2001 CSO Mortality Table, the 35-year-old has life expectancy probabilities detailed in the chart below. As shown, there is a 5 percent probability that the insured will live to age 96.

Probability of Living to Age:

84

50%

91

20%

96

5%

Since the probability of living to age 121 is very low, the insured may be able to save additional money by shortening the guaranteed death benefit duration. However, for simplicity, we will assume the age 121 policy design and corresponding premium levels for this analysis.

Over the life of the policy, the chart below shows the expected cumulative premium outlays for the GUL policy based on the corresponding life expectancies. If the insured lives to age 96, the cumulative premiums paid into the policy will be approximately $270,000.

Probability of Living to Age:

GUL Cumulative Premiums

84

50%

$216,874

91

20%

$243,430

96

5%

$269,986

If permanent coverage is needed and the policy is held until mortality, buying permanent coverage now will be the least expensive option for securing $1 million of life insurance if the insured lives to median life expectancy or beyond.

Buy term and convert to permanent alternative

Instead of purchasing the GUL policy at age 35, the insured could choose to buy convertible term insurance for a period of 10, 20 or 30 years with the intent of converting to permanent insurance at the end of the term period. Annual term insurance premiums from the same insured are listed below.

Term Period

Annual Term Premiums

10

$505

20

$805

30

$1,105

As you can see, the annual term insurance premiums shown above are significantly less expensive than the GUL premiums of $4,426 per year. However, the cost of a GUL policy becomes much higher and more costly as an insured ages and when it becomes time to convert the 10, 20 or 30 year term insurance policy to permanent coverage.

Term Period

Annual Term Premiums

Age At Conversion

Annual GUL Premiums

10

$505

45

$7,186

20

$805

55

$12,651

30

$1,105

65

$22,035

Over the life of the insured, the term conversion plans become much more expensive than buying the original GUL policy at age 35 for the same amount of coverage and duration. The chart above highlights how expensive it becomes to convert term insurance at older ages. For instance, the annual premiums required to convert a term policy at age 65 increases to over $22,000 per year.

When the 30-year term policy is converted to permanent insurance at age 65, the total premiums paid over the insured’s life for this alternative increases from over $216,000 to $451,000 if the insured lives to median life expectancy of age 84. The combined cumulative cost of the insurance is over double (108 percent) the cost of the GUL policy purchased at age 35 for the same $1,000,000 of coverage.

If the insured lives to age 96 (5 percent chance), the cost is over 165 percent more ($716,000 compared to $270,000 for the original GUL policy). Although this analysis doesn’t compensate for the time value of money, the differences can be substantial.

The chart below highlights the total cumulative premiums paid over the designated lifespan for the various alternatives:

Probability of Living to Age:

GUL Cumulative Premiums

10 Yr Term Conversion Premiums

20 Yr Term Conversion Premiums

30 Yr Term Conversion Premiums

84

50%

$216,874

$285,304

$382,979

$451,815

91

20%

$243,430

$328,420

$458,885

$584,025

96

5%

$269,986

$371,536

$534,791

$716,235

The chart below highlights the percentage increase in premiums over the designated lifespan for the various alternatives:

Probability of Living to Age:

10 Yr Term Additional Cost

20 Yr Term Additional Cost

30 Yr Term Additional Cost

84

50%

32%

77%

108%

91

20%

35%

89%

140%

96

5%

38%

98%

165%

New coverage needed after term conversion privilege inadvertently expires

The policyholder may be under the assumption that the agent who sold the policy or the insurance carrier will notify the insured when the conversion privilege is expiring, but this is very naïve. Very few insurance carriers send notifications of term conversion privileges. In addition, many policies become orphaned (with no assigned agent) for various reasons. Moreover, many agents who may be currently active in their careers are of an age when retirement is looming and in many instances won’t be actively working when the conversion privileges begin expiring in 10, 20 or 30 years.
If the term period expires before the conversion privilege is exercised and the insured’s health has changed, the differences in the overall financial cost of the coverage can become even more drastic. The chart below shows the GUL premiums assuming new underwriting requirements and standard non-tobacco underwriting classification. These annual premiums are over 25 percent higher than the comparable preferred non-tobacco underwriting premiums at the given ages under the term conversion scenario.

Term Period

Annual Term Premiums

Age At Purchase

Annual GUL Premiums

10

$505

45

$9,249

20

$805

55

$16,099

30

$1,105

65

$27,800

Life expectancies for standard non-tobacco underwriting at new issue ages of 45, 55 and 65 respectively will be slightly lower (one to three years lower on average) than the previously illustrated life expectancies for an age 35 preferred non-tobacco insured. However, for comparison purposes, we will use the same life expectancy ages.

In the scenario where the insured has a 30-year term policy that expires and purchases new permanent GUL insurance at age 65 with standard non-tobacco rates, the cumulative cost of the insurance is over 159 percent more if the insured lives to age 84. Total premiums over the life of the plan could increase from over $216,000 (original scenario) to $561,000 for the same amount of coverage and duration.

If the insured lives to age 96, the cost is over 231 percent more ($895,000 compared to $270,000 for the original GUL policy).

The chart below highlights the total cumulative premiums paid over the designated lifespan for the various alternatives:

Age

GUL Cumulative Premiums

10 Yr Term Plus GUL Premiums

20 Yr Term Plus GUL Premiums

30 Yr Term Plus GUL Premiums

84

$216,874

$365,761

$482,971

$561,350

91

$243,430

$421,255

$579,565

$728,150

96

$269,986

$476,749

$676,159

$894,950

The chart below highlights the percentage increase in premiums over the designated lifespan for the various alternatives:

Age

10 Yr Term Additional Cost

20 Yr Term Additional Cost

30 Yr Term Additional Cost

84

69%

123%

159%

91

73%

138%

199%

96

77%

150%

231%

Premium disparities for an insured with poorer health (e.g., sub-standard or rated underwriting classifications) are even greater.

This analysis highlights the importance of evaluating and understanding life insurance alternatives and policy management expectations. It is often more financially prudent to secure some level of permanent life insurance upfront to save on long-term costs. In addition, a permanent life insurance purchase avoids the significant cost increase of converting term insurance to permanent coverage at later ages and the risk that the conversion privilege will expire before utilization.

This analysis also highlights that it doesn’t pay to delay insurance purchases. Although policy pricing may go up or down in the future, the cost of insurance coverage increases with age. A significant change in health may have a detrimental impact on the ability to secure a preferable underwriting classification in the future. Locking in coverage now, whether convertible term or permanent, may be one of the most important financial decisions you can make.